What Is Fiscal Policy?
Fiscal policy refers to decisions by the government, in the U.S., Congress and the president, about how much to spend, what to tax, and how much to borrow. It is one of the two main levers for steering the economy, alongside monetary policy, which is run by the central bank.
Expansionary fiscal policy means bigger deficits through tax cuts or new spending, designed to boost demand when the economy is weak. Contractionary policy does the opposite, shrinking deficits to restrain an overheating economy or stabilize government debt.
How It Works
Government spending adds directly to GDP, while tax changes work indirectly by altering how much households and businesses have to spend and invest. Economists measure the punch of each dollar with the fiscal multiplier: infrastructure spending or benefits to lower-income households tend to have higher multipliers than tax cuts for high savers.
Some fiscal tools operate automatically. Unemployment insurance and progressive taxes act as automatic stabilizers, expanding support in recessions and withdrawing it in booms without any new legislation.
Example
During the 2020 pandemic, the U.S. enacted roughly $5 trillion of fiscal support, including direct checks, expanded unemployment benefits, and business loans. The federal deficit swelled to about 15% of GDP, the largest since World War II, and the stimulus helped demand rebound sharply, though it also contributed to the inflation spike that followed.
Why It Matters
Fiscal policy shapes markets through the bond market: large deficits mean heavy Treasury issuance, which can push yields higher and raise the risk-free rate used to value all other assets. Tax policy also flows straight into corporate earnings models, since a change in the corporate tax rate directly changes net income.
For analysts, the interplay between fiscal and monetary policy is a core macro question. Stimulus during tight monetary policy, for instance, can keep inflation and interest rates higher for longer than markets expect.
